Updated on January 23rd, 2020 by Samuel Smith
For superior long-term returns, investors should focus on high-quality dividend growth stocks. This comes to mind when reviewing the Dividend Aristocrats, a select group of 57 companies in the S&P 500 Index with at least 25 consecutive years of dividend increases.
We have created a free Excel list of all 57 Dividend Aristocrats, along with relevant financial metrics such as P/E ratios and dividend payout ratios.
You can download the full list by clicking on the link below:
We review all 57 Dividend Aristocrats each year. The 2020 Dividend Aristocrats In Focus series continues with beverage giant The Coca-Cola Company (KO).
Not only is Coca-Cola a Dividend Aristocrat, it is a Dividend King as well. The Dividend Kings have increased their dividends for 50+ consecutive years. You can see all the Dividend Kings here.
Coca-Cola has a dividend yield of 2.8%, which is considerably higher than the S&P 500 average yield of 1.7%. In addition, Coca-Cola is likely to continue raising its dividend each year.
But this is a difficult time for Coca-Cola. Consumer preferences are changing, and soda consumption continues to wane in the U.S. Because Coca-Cola’s earnings growth has slowed, the stock continues to appear overvalued. However, it remains a high-quality business with strong brands, and an attractive dividend yield.
In addition, it has been diversifying away from sparkling beverages in recent years and those efforts have paid off. Growth appears to be on the horizon, improving the outlook for the beverage giant.
This article will examine Coca-Cola’s investment prospects in detail.
Coca-Cola was founded in 1892. Today, it is the world’s largest non-alcoholic beverage company. It owns or licenses more than 500 non-alcoholic beverages, including both sparkling and still beverages.
It now sells products in more than 200 countries around the world, and has 21 brands that each generate $1 billion or more in annual sales.
The sparkling beverage portfolio includes the flagship Coca-Cola brand, as well as other soda brands like Diet Coke, Sprite, Fanta, and more. The still beverage portfolio includes water, juices, and ready-to-drink teas, such as Dasani, Minute Maid, Vitamin Water, and Honest Tea.
Source: Investor Presentation
Coca-Cola dominates sparkling soft drinks, where it commands over 50% market share. The company is attempting to maintain and even improve this dominant position with product extensions of existing popular brands, including reduced and zero-sugar versions of brands like Sprite and Fanta.
This is a challenging time for Coca-Cola. Sales of soda are slowing down in developed markets like the U.S., where soda consumption has steadily declined for years. For example, a recent report states that soft drink consumption in the United States declined in 2018 for the 13th consecutive year. Further, since peaking at 53 gallons in 2000, soda consumption has declined by 25%.
Declining soda consumption is a significant challenge for the company. While Coca-Cola’s total volumes certainly still rely upon sparkling beverages such as soda, the company has gone to great lengths in recent years to diversify away from its core products, understanding that the long-term growth prospect for sparkling beverages isn’t particularly inspiring. Coca-Cola has acquired multiple still beverage brands in recent years.
Coca-Cola reported Q3 earnings on 10/18/19, and results were solid. Key strategic initiatives continued to advance in management’s pursuit of innovation, revenue growth management, and digitization, driving strong organic growth.
Revenue grew by a robust 8% year-over-year with growth across all business segments. The gross operating margin was 60.4% and the adjusted operating margin was 28.1%, falling by a steep 250 and 470 basis points, respectively, from the year-ago quarter. However, this was not necessarily due to a declining business, as currency headwinds, a shift to lower margin products, and timing of transactions all impacted this negatively.
On 2/21/19, Coca-Cola authorized its 57th consecutive annual dividend increase, raising the payout from $1.56 to $1.60 per year. We expect a 58th consecutive annual dividend hike next month as well.
In an effort to return to growth, Coca-Cola has invested heavily outside of soda, in areas like juices, teas, dairy, and water, to appeal to changing consumer preferences. Despite weak guidance from an earnings perspective in 2019, we continue to see Coca-Cola as having a favorable long-term growth outlook.
One reason we like the stock is because it competes in an industry that continues to grow globally in excess of the rate of broad economic growth. This leads to strong levels of overall growth in the industry, which Coca-Cola has certainly been capitalizing on in recent years.
In addition, the ready-to-drink category is sold through highly-diversified channels and continues to have mid-single digit projected growth rates, both for Coca-Cola and the industry. This is particularly true for still beverages like milk, tea and water. Coca-Cola’s years-old strategy to diversify away from sparkling beverages is due to this and it is undoubtedly bearing fruit.
Coca-Cola also continues to acquire brands in order to grow, including its unexpected acquisition of Costa, a coffee brand based in the UK.
Source: Investor Presentation
This is certainly an out-of-the-box buy for a sparkling beverage behemoth, but Coca-Cola is doing what it takes to secure its future.
Finally, we continue to like the nearly-complete plan to divest the company’s bottling operations. The major portions of the plan are complete and the rest should be done shortly as the company is looking to sell its India bottling assets.
This has resulted in some pretty significant revenue declines over the years, but the end goal is higher margins. That has already begun occurring and with completion of the transformation in 2019, revenue growth will return. Not only will revenue move higher, but margins will continue to do so as well.
Taking all of this into account, in addition to the company’s ample buyback program and productivity improvement efforts, we see total earnings-per-share growth of 6% annually in the coming years. 2019 and the beginning of 2020 are years of transition thanks to the bottling divestitures, but Coca-Cola should see meaningful growth beginning later this year.
The company’s dividend is now up to $1.60, a 2.6% increase from the prior payout. The current yield is 2.8%, which is within its normal bound over the past decade. On this measure, when taken in combination with its long dividend growth streak, Coca-Cola seems fairly attractive to income investors.
Competitive Advantages & Recession Performance
Coca-Cola enjoys two distinct competitive advantages, which are its strong brand and global scale. According to Forbes, Coca-Cola is the sixth-most valuable brand in the world. The Coca-Cola brand is worth $59.2 billion.
In addition, Coca-Cola has an unparalleled distribution network. It has the largest beverage distribution system in the world. Of the roughly 60 billion beverages consumed around the world every day, about 2 billion come from Coca-Cola.
These advantages allow Coca-Cola to remain highly profitable, even during recessions. The company held up very well during the Great Recession:
- 2007 earnings-per-share of $1.29
- 2008 earnings-per-share of $1.51 (17% increase)
- 2009 earnings-per-share of $1.47 (3% decline)
- 2010 earnings-per-share of $1.75 (19% increase)
Not only did Coca-Cola survive the Great Recession, it thrived. Coca-Cola grew earnings-per-share by 36% from 2007-2010. This shows the durability and strength of Coca-Cola’s business model. The company’s dividend also appears very safe.
Valuation & Expected Returns
Coca-Cola expects adjusted earnings-per-share to be roughly flat this year despite a mid-single digit rise in organic revenue. At our current estimate of $2.10 for this year, Coca-Cola trades for a price-to-earnings ratio of 27.4.
This is a premium of approximately 44% from our fair value estimate of 19 times earnings, which takes into account the stock’s historical valuations as well as future growth estimates. Should the stock revert to our fair value estimate of 19 times earnings, it would introduce a 7% headwind to total annual returns.
Putting all of this together, we expect total annualized returns of ~2%, consisting of the 2.8% dividend yield, 6% earnings growth and a 7% headwind from the valuation. Because the stock appears to be significantly overvalued, the corresponding contraction of the valuation multiple is expected to meaningfully reduce total returns over the next five years.
Coca-Cola has made great strides repositioning its portfolio to meet changing consumer tastes. It has built a large portfolio of juices and teas, to cater to a more health-conscious consumer.
There is more work to be done to diversify away from sparkling beverages, and we see much-improved growth prospects beginning in 2020.
We rate the stock a sell given its valuation, but we very much like Coca-Cola’s dividend as well as its improved growth outlook. Coca-Cola is a time-tested Dividend Aristocrat, and will very likely continue increasing its dividend each year.